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ETF Hedges Extreme Market Behavior

There are funds that use futures contracts, swaps and other derivatives to deliver an exposure that is more complex than a basket of stocks. In addition to VIXH there are levered and inverse index funds, products tracking Italian bond futures (no, really,) and other products that require some understanding of the derivative products the fund will use and the market being replicated.

A great example of possible investor disappointment can be seen in comparing the iPath S&P 500 VIX Short Term Futures ETN (VXX) and the actual VIX index. Since inception in February 2009 VXX is down 97% while the underlying index is only down 66%. This is due in part to VXX tracking near term futures not the actual index and the extent to which replacing expiring futures contracts with replacements is often done at a loss, a market condition known at contango.

The expense ratio for VIXH is 0.60% which isn't necessarily expensive if the strategy protects investors from some sort of large market decline, but if the Federal Reserve Bank's policy of QE-Infinity continues to send markets higher, then VIXH will lag plain vanilla index funds.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.
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